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Market Update

Bank of England base rate hiked for fifth consecutive meeting

Date:
June 16, 2022

Summary

On 16 June, the Bank of England (BoE) voted six to three to raise the U.K. base rate by 0.25% to 1.25%, with all three dissenters voting in favour of a 0.50% hike. The hike represents the fifth straight hike by the BoE since they became the first major central bank to begin monetary tightening. The market is pricing in a further 1.50% increase to by end of year, to reach rates of just under 3.00%. GBP weakened immediately following the announcement as traders unwound hedges against a 50 bps hike that was priced at 35% likelihood coming into the monetary policy committee (MPC) meeting. The 10-year gilt yield trimmed two bps ten minutes after the announcement, with the 2-year gilt dropping four bps. The GBP-USD currency pair has made new 35-year lows to trade just above the $1.2 level, with extra downward pressure being applied in the wake of the Fed’s 0.75% hike just 17 hours earlier. The BoE added that should inflation remain high, it would, “if necessary, act forcefully in response”. The threshold for such action was kept vague and the absence of a post-decision press conference allows the BoE to remain slightly non-committal as economic conditions are evolving.

Key takeaways

  • The Bank of England raised the base rate by 0.25% to 1.25%.
  • The 10-year gilt yield traded at 2.53%, down two bps, post announcement, with the 2-year gilt yield trading at 1.95%, down four bps.
  • The market is currently pricing in a 95% chance of a further 0.50% hike in each of the next two meetings, with a total of 150 bps of further increases expected across the four remaining MPC meetings in 2022.
  • The vote was split six to three in favor of a 0.25% hike, with all three dissenters voting for a 0.5% increase.

The lead up to the mid-year MPC meeting saw the central bank under increasing pressure to act more decisively, the U.K. continuing to print 40-year inflation highs; the consumer price index (CPI) and retail price index (RPI) indexes at over 9% and 11% respectively. The recent inflation data, observing April, does not yet include the further upward price pressure caused by the E.U. led scheme to ban Russian owned ships from the insurance and reinsurance markets. This will cause further supply disruption to trade in dry and liquid commodities. The likelihood of a hawkish 0.50% hike from the BoE came into focus as a real possibility following a surprise 0.50% hike from the Swiss National Bank earlier on Thursday, hot on the heels of the Fed’s 0.75% rate hike on Wednesday.

Despite sticking with the 25 bps hike, the BoE indicated that they would follow the Fed’s lead should inflation persist by noting, “it would be particularly alert to indications of more persistent inflationary pressures, and would, if necessary, act forcefully in response.” This was supported by all nine members of the MPC; a notable shift from May when two members disagreed that further hikes were needed in 2022 at all. There is much discussion about the balance between managing inflation and the negative impact on economic growth of higher interest rates. We should remember that the MPC’s role is solely focused on price stability, not other aspects of economic growth. They reiterated this in the minutes, “the MPC’s remit is clear that the inflation target applies at all times reflecting the primacy of price stability in the UK economic framework.”

3 month compounded SONIA forward curve

The BoE statement did also emphasise that inflation is no longer only driven by global factors, implying that a potential wage-price spiral could push inflation higher. This will cause greater scrutiny to be applied to the core CPI measure in the coming months as the market attempts to anticipate future BoE base rate moves. The BoE adjusted its forecast up for the peak CPI inflation this year to “slightly above” 11%, led by the planned increase in the energy price cap in October. It expects the economy to experience a Q2 contraction. The statement offered no further detail on the timeline for quantitative tightening, with September still expected to be the earliest possible date for commencement.

More broadly, data earlier this week showed the economy contracted in April, with officials predicting it will shrink 0.3% in the second quarter, after previously expecting a 0.1% expansion. The Organisation for Economic Co-operation and Development (OECD) stated the U.K. will be the only developed nation to report no economic growth in the next year.

UK CPI Inflation

Another inflationary influence is the fiscal expansion delivered by Rishi Sunak, Chancellor of the Exchequer in the form of a multi-billion-pound relief program to help households cope with the U.K.’s cost of living crisis. The BoE estimated that the government package could raise the level of output by around 0.30%, and further fuel and CPI inflation by 0.10% across the next 12 months “with some upside risks around these estimates.”

The current MPC committee now boasts a consecutive rate hiking sequence unmatched since monetary policy was transferred from the government to nine unelected BoE officials in 1997, marking their independence from the U.K. government. The market will now have to take a wait and see approach for six weeks, barring any emergency meetings, with intervening data releases likely to cause heightened market volatility.

The next meeting is on 4 August, with further meetings in September, November, and December.

To follow the developments of the market’s expectations of the forward interest rates visit ChathamRates or contact us using the form below.

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